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TESTING?

The early August decline was followed by an almost instantaneous 50% rebound, which was not the product of a SAMMY buy signal, nor accompanied by a positive divergence in the premium/discount indicator, which is shown in the lower panel of the attached TATY strategic indicator. The update following the rebound rally suggested there would likely be a test of the early August low given the lack of a bona fide Sammy buy signal, and the lack of a positive divergence. It was also suggested the 50% recovery rally must continue to above the 62% recovery range to turn the odds in favor that the early August spike down was going to be a complete correction. On Friday the questions surrounding a possible test of the low were answered, when the Dow painted out another Dow 600 point plus decline. The rest of this update will lay out how we view what is likely to happen next vis-à-vis our supply and demand approach to managing market risks.

TATY — A FAMILY OF STRATEGIC SUPPLY AND DEMAND INDICATORS CHART 1

Last week’s update noted that TATY appeared to have completed a bottom in the red zone, and it would have to continue to paint out bottoms in, or near, the red zone for the recovery rally to enjoy enough strength to mount another assault on new all-time highs. That observation is still valid. However, it is now evident that the suggested test of the early August low will have to be completed before the TATY indicator will have its next opportunity to paint out a bottom in the red zone. Between now and then another big question will likely have to be answered, which is will the test of the low be completed with the development of a large positive divergence in place in an array of indicators, or will the test of the low generate an excursion into the caution zone surrounding the 115-125 TATY level. Such a development would then trigger the first step in a “Big Chill” warning. Should the TATY indicator then mount an expiring rally into, or near the red zone, an official Big Chill warning would be issued.

A “Big Chill” warning would be an important development, because every major top, and major rebound top during big bear market rebound rallies since the 1990’s have been preceded by a “Big Chill” warning. I suspect major tops before the 1990’s were also, but the data necessary to re-create the TATY indicator does not exist in eSignal format, making the indicator too expensive and complicated to re-create. However, the major topping process was tracked by Lowry Research all the way back to 1925, and within their discipline the topping process was always the same. This suggests the “Big Chill” process likely would have been the same as well, since my work includes representative derivative modules in addition to the Lowry NYSE only type data inputs in their indicators. Given the huge amount of risks being managed by derivatives these days, failure to supplement NYSE data with derivative representative input would tend to mis-represent the overall balance of supply and demand driving the price of stocks.

In any case, some of the most important market disruptions since the 1929 “Granddaddy” of them all tops occurred beginning with the crash of Long Term Capital in the summer of 1998 until the present, making the post 1998 period a good test sample. So, the bottom line for this section is a test of the early August low is obviously underway, and this test will likely create a tradable bottom as long as TATY stays above the caution zone surround the 115-125 level. A TATY decline into the caution zone would suggest a big change in the character of the balance of supply and demand, which could lead to the necessity of taking defensive actions to preserve accumulated profits, and/or lower client risk exposure to equities.

Clients will note that we were not a buyer near the early August low, because the stock market did not serve up a relatively low risk entry according to our indicators. We told clients we would be buyers, if the tactical indicator SAMMY issued a clear buy signal, and positive divergences were in place with the strategic family of indicators represented by TATY, and its premium/discount indicator shown in the lower panel of the TATY chart. These conditions were not met, so we stood aside and waited. Now it appears a test of the low is well underway, which may result in our conditions for a low risk purchase being met for excess cash needing to be invested, or for new clients coming into our ETF model in cash.

Alexander and I are risk managers first, and that means maintaining discipline, especially when the market enters a hurly burly period of volatility, because our discipline will likely allow us to turn chaos and volatility into opportunity for our clients. Alexander and I do not fear bear trends, or outright violent bear markets, because buying when great companies are selling at substantial discounts to “value” lies at the very core of how we operate. Our proprietary market tools are well suited for this approach, which leaves our competitors at huge disadvantage given that most excel at developing relationships, and actually managing money to a consistently superior risk adjusted return not so much.

THE BOTTOM LINE

A test of the early August low is obviously underway. If the test of the low results in a favorable outcome for a low risk entry to put excess cash, or new cash coming in from new clients to work in equities, then we will take advantage of the opportunity. Such a buy signal would occur after a long and possibly fatigued rally, but with the expectation that it would still result in a profitable trade, and/or investment. However, if the test of the low results in the strategic indicator, TATY, declining into the caution zone, then a change in character, and the balance of supply and demand for equities may be at hand. If the TATY indicator was to complete an official “Big Chill” warning, then defensive actions may become necessary to protect accumulated profits, and/or to lower the potential impact of rising market risks to clients.

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